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China: Great Wall, Great Mall, Great Fall? Not really…
Executive summary
September 9, 2015

Cracks in the Wall, our core scenario for China (60%
likelihood) envisions growth of +6.8% this year and +6.5%
in 2016, costing the world 0.1pp of GDP growth so far.
Lower export growth, decelerating investment, less
favorable financing mix and misperceptions of policy
orientation are the underlying causes for this slowdown;
the stock market crash was a mere artefact.

Though domestic consumption is set to remain solid,
Government and Central Bank support will eventually
ramp up to address remaining instability. However,
corporate insolvencies will increase by +25% in 2015, and
+20% in 2016. Sectors at risk include: Construction,
metals and mining, low-end manufacturing and exportrelated industries.

Overall, the impact on global growth will be limited (-0.1
pp of GDP) but dramatically uneven. In the next 6
months, commodity exporters will particularly feel the
heat. Indonesia and Malaysia, Peru and Chile and South
Africa are tier 1 of impacted countries. Other countries
linked to China’s manufacturing value chain (such as
Taiwan) are also at risk.

Alternative scenarios (sharper contraction – 30% and
excessive stimulus – 10%) are also considered but
remain less likely. All in all, China’s new model is taking
shape but it does not go unnoticed.
Mahamoud Islam, Economist for Asia
 [email protected]
Ludovic Subran, Chief Economist
 [email protected]
China 2015-16: Cracks in the Wall
We revised down our growth forecast for China
this year to +6.8% in 2015 and +6.5% in 2016
with a possible deviation of +/-0.2pps each
year. This revision reflects lower growth in exports
and investment, a less favorable financing mix and
prevailing deflationary pressures. Domestic
consumption is set to remain resilient with
progressive improvement in private consumption.
In the short term, risks are tilted to the downside
as misperceptions on policy orientation continue to
weigh on the outlook. In the longer term, the
growth mix (strong growth in domestic
consumption, higher living standards) will likely
matter more than the growth target.
Private consumption growth has been resilient
so far but is still not sufficient to compensate
for lower export growth and reduced
investment growth; the economy continues to
rely on government support. Official business
surveys (manufacturing PMI) reveal lower
employment in industry and consumer confidence
is adjusting downward following stock market
corrections. The latter does not pose a systemic
Table 1: China’s economic dashboard
Economic activity - hard data
Mar-15 Apr-15 May-15 Jun-15 Jul-15
Aug-15
Real industrial production (y/y)
5.6
5.9
6.1
6.8
6.0
na
Nominal Retail sales (y/y)
10.2
10.0
10.1
10.6
10.5
na
8.9
8.5
8.9
9.2
8.9
na
Nominal Government expenditures (y/y)
4.4
33.2
2.6
13.9
24.1
na
Nominal Investment in Fixed Assets (YTD, y/y)
13.5
12.0
11.4
11.4
11.2
na
Nominal USD Exports (y/y)
-15.0
-6.4
-2.5
2.8
-8.3
-5.5
Nominal USD Imports (y/y)
-12.7
-16.3
-17.6
-6.1
-8.1
-13.8
3.1
34.1
59.5
46.5
43.0
60.2
Credit outstanding to non fin. institutions (y/y, %)
13.5
13.6
13.8
14.0
14.6
na
Lending Rate (%)
5.35
5.35
5.10
4.85
4.85
4.60
Reserve Requirement ratios for large banks (%)
19.5
18.5
18.5
18.5
18.5
18.0
Stock market - Shanghai stock exchange (m/m)
13.2
18.5
3.8
-7.3
-14.3
-12.5
Retail sales-CPI deflated (y/y)
Trade balance (USD bn)
Financing conditions
Sources: IHS, Euler Hermes
threat so far. However the cyclical risk is significant
especially on household confidence. Public support
will increase at a stronger pace to support growth in
the form of infrastructure and social spending, lower
taxes for vulnerable companies and better financing
conditions. Private consumption is set to accelerate
gradually thereafter.
Financing conditions are not supportive
enough.
Authorities
want
to
decrease
concentration risks through a slowdown of
corporate debt and diversification of financing
channels. Credit intensity (the amount of credit
needed to generate one more RMB of growth) has
deteriorated in recent years and now China needs
close to +RMB3.3 of new credit to create +RMB1 of
growth (compared to RMB1.8 in 2011). Formal
credit is increasing but its growth rate is not enough
to compensate for the reduction in shadow banking
activities. Financial market effectiveness has
deteriorated significantly during the summer and the
economy has to rely more on bank credit to grow. In
Jan-Jul 2015, China provided +RMB9.5tn of new
credit to the economy with +RMB7.2tn coming from
the banking sector. To achieve a growth of
+RMB5tn (+8% nominal growth), China will need to
provide +RMB16.7tn of new credit this year,
+RMB13.6tn in bank credit.
Graph 1: Aggregate credit flows (Jan-Jul, cumulated,
RMB bn)
12000
Non-financial
enterprise equity
financing and other
10000
Corporate bonds
8000
Shadow banking*
6000
Bank loans
4000
Aggregate credit
(Total Social
Financing)
2000
0
13
14
15
* Using IMF dissemination, it refers to trust loans, entrusted
loans and bank acceptances
Sources: IHS, Euler Hermes
It’s the policy, stupid!
Misperceptions of policy orientation will
continue to weigh on the outlook. In a world
where major economies tend to be transparent on
their policy orientation, the unexpected change in
the exchange rate formation mechanism and the
following currency devaluation have been seen as
an early indicator of worsening economic activity
and the beginning of a continued currency
depreciation. Timing (right after disappointing data
releases) and change in methodology contrasted
markedly with previous announcements (including
extensions of the currency trading band in July).
Going forward, easing measures and a revamp
of economic guidance are expected. With
ongoing financial instability and weak economic
data, the government is set to increase support
Euler Hermes Economic Research
measures. These include: direct support to growth
through higher public expenditures and higher credit
supply but also indirect measures such as the
development of other formal financing channels
such as finance companies and trade credit
insurance. Recent measures (cuts in both policy rate
and Reserve Requirement Ratios, reduction in
corporate income tax) will probably start to bear fruit
in Q4 due to the time lag in policy transmission.
Regarding financial markets, the authorities are
likely to increase financial buffers (further liquidity
injections) to avert further correction. On top of these
easing measures, we expect a progressive revamp
of China’s economic guidance, with more
reasonable and more flexible growth targets
(perhaps a range of +6% to +6.5%) and with more
focus on the growth mix than the growth rate itself.
This will help to reduce the extreme sensitiveness to
hard data financial markets have experienced so far.
Financial volatility is set to remain elevated but
systemic risk will be contained. First, Eurozone
hiccups and currency carnage in emerging markets
put pressure on the Chinese export model. Second,
China’s internal transformation is kicking in (see
table 2) and the banking system and private sector
need to adapt, creating some volatility along the
way. However, systemic risk linked to the stock
market crash is not plausible as financial markets in
china are not deep enough: Market capitalization of
major stock exchanges is lower than 50% of GDP
(see Graph 2). The authorities still have the upper
hand with Reserve Requirement Ratios and high
policy rates. Households also have some buffers as
income revenues are still on a positive trend and
savings are significant (urban households saving
rates is close to 30% GDP). Companies will
probably be those which will bear the brunt of the
adjustment in the short run, especially financial
services.
The renminbi has re-pegged and should not
depreciate sharply. Since poor export performance
is linked to external demand, currency should not be
tampered too much. China’s export market share is
still increasing (see Graph 3) but price
competitiveness has eroded because of increasing
labor costs. Non-price competitiveness has
increased significantly through innovation and better
positioning though. Downward pressures on the
Graph 2: Domestic market capitalization
(% GDP)
120%
100%
80%
60%
40%
20%
0%
China Japan - Tokyo US - New York
Shanghai SE*
SE
SE
SE* refers to Stock Exchanges
Sources: World Federation of Exchanges, IHS, Euler Hermes, July 2015
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renminbi do exist (correction after sharp
appreciation, investors’ concerns about China’s
economy and diverging monetary policies).
Assuming that China gradually eases control of the
currency, we foresee a maximum deviation of +10%
(from 6.36 RMB/USD), which will bring the
RMB/USD parity to 7 over one year. The potential
impact on net trade will be positive (+0.2pp of
GDP).
Table 2: Financial liberalization – key actions
Financial liberalization - key actions
• RMB trading band widened from 1% to 2%
March • Foreign investors on Shanghai Comp allowed to invest in more
products and up to 30% in single company (vs. 20%)
• Shanghai-Hong Kong Stock connect is launched
2014
• PBoC cut benchmark lending and deposit rates; deposit rate
November
ceiling raised from 1.1 times the benchmark level to 1.2 times
• PBoC widens deposit base for banks in banks loan to deposit
ratios
January • Government issues guidelines for futher Free Trade Zones
• PBoC increased availability of its Short-term Liquidity Facility to
allow more banks to get 1-3 month liquidity
February
• PBoC cut benchmark lending and deposit rates; deposit rate
ceiling raised from 1.2 times the benchmark level to 1.3 times
• Governor Zhou - "probability of full interest rate liberalization by
the end of the year is high"
March • Primer Li - "China will speed up the basic convertibility of RMB
on the capital account"
• Mutual funds got access to Shanghai-Stock connect
• IMF announces that RMB on path to inclusion in SDR basket
2015
April
• Mainland Chinese buying of Hong Kong share via ShanghaiHong Kong stock connect reaches daily quota for first time
• Deposit insurance scheme goes live. The insurance system
will guarantee deposits of up to 500,000 RMB ($81,000).
May
• PBoC cut benchmark lending and deposit rates; the ceiling for
deposit rates was raised to 1.5 times the benchmark level (fron
1.3)
December
June
• PBoC cut benchmark lending and deposit rates
July
• Chinese State Council announced that China will widen RMB
trading band soon
• Change in exchange rate formation mechanism: the daily
opening fixing rate of the RMB is based on the previous trading
August day’s closing
• PBoC cut benchmark lending and deposit rates; abolition of the
cap on deposit rates with maturities over one year
• Loan to deposit-ratio scrapped (75% before)
Sources: Scotia Bank, local press, Euler Hermes
Graph 3: China’s global export share
(12m rolling average)
18%
China
16%
Germany
United States
14%
Japan
12%
10%
8%
6%
What does it mean for credit risk in China?
Corporate insolvencies will increase by +25% in
2015 and +20% in 2016. Insolvencies increased by
+13% (12m/12m) in July. To date, industrial profits
for large companies remain on a downward trend
(-1% YTD, y/y in Jan-July). With an improvement in
credit conditions domestically and a gradual
increase in global demand (both domestic and
external) from Q4 2015 onwards, the increase in
insolvency should be contained in 2016. Note that
Insolvencies number in 2016 (3920) will remain
below 2009 level (4448).
Sectors at risk include: Construction, metals
and mining, low-end manufacturing and exportrelated industries. To date, only some sectors in
the higher-end segment and within government
targets are showing signs of resilience (high-tech,
chemical and commodity processing). The
construction sector is particularly struggling as
downward price pressures prevail with large
overcapacity and weak demand prospects. Primary
commodity for manufacturing such as metals and
mining experience a perfect storm: lower
commodity prices, lower demand from domestic
industries (such as construction) and lower external
demand. We also see increasing risks in low-end
manufacturing and sectors driven by external
demand (textile and low-end electronics). These
sectors suffer from stronger regional competition
(from Vietnam and Bangladesh). For electronics the
contraction in Taiwan (one of the biggest suppliers
of electronic components to China) in Q2 (-1.7%
q/q) should nudge the sector this quarter.
Who is impacted outside China?
Overall, the impact on global growth will be
limited (-0.1 pp of GDP) but dramatically
uneven. In the next 6 months, commodity
exporters will feel the heat. Commodity exporters
are affected by both the price shock and the
demand shock by China (both of them being
related). Growth forecasts have been lowered and
the upcoming Fed hike will probably exacerbate
external vulnerabilities and shave off more growth.
In Asia, Malaysia and Indonesia are primary victims
due to existing imbalances, including a current
account deficit (for Indonesia) and large public
deficits and high household debt (in Malaysia).
Policymakers will focus on ensuring financial
stability, Thailand and Vietnam will also be affected.
Australia and New Zealand are also on the radar
but policy response is more effective and public
debt is low. Outside Asia, Latin American countries,
such as Chile and Peru and African countries such
as South Africa will also be impacted. For a full list
of countries at stake, see table 3 for net trade
surpluses with China, and policy room to
manoeuver.
4%
2%
0%
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Sources: IHS, Euler Hermes
Euler Hermes Economic Research
The second tier of impacted markets include
those dependent on China’s manufacturing
value chain such as South Korea, Taiwan,
Singapore, Hong Kong and, to a lesser extent,
Japan. Most of these countries have strong buffers
3
(monetary policy and sound public finances). They
can withstand a cyclical shock (sharp deceleration in
China) but in the longer term they will have to adapt
to the Chinese new normal. Taiwan is probably the
most vulnerable as its economy is highly linked to
China’s electronics industry. With China trying to
move up the value chain and being more
autonomous in terms of production, the situation will
be more challenging for Taiwanese companies.
Other trade partners such as Germany will feel
some cyclical headwinds due to large export
exposure but strong positioning will allow solid
performance. Turnover growth for exporters should
be revised slightly downward as private demand is
improving but moderately and local competitors are
emerging, in spite of the adverse financing
conditions.
Most
exposed
sectors
include
automotive and machinery. However, strong
positioning on quality products, technological
advantage and agility to new Chinese model (more
quality friendly) can help prove resilient.
If push comes to shove…
Our alternative scenario The Fall (30% probability)
includes a sharp deceleration in private expenditure
coupled with insufficient policy support. GDP
growth will slip to +6.5% (or below) this year and
around +6% in 2016. Corporate risks will intensify
especially in traditional industries and highly
subsidized ones (high-tech electronics, e.g.).
Confidence will continue to fall and external
financing will tighten (large capital outflows). This
could trigger a large currency depreciation (up to
25%), probably buffered by other Central Banks,
but reinforcing deflationary pressures. Under this
scenario, the direct impact on global growth will be
more significant (-0.3 pp of global GDP) and export
revenues will be affected beyond commodity
exporters and traditional Chinese providers. In
particular, high-end goods exporters (including the
U.S., Germany and France) will be affected in
specific key industries such as electronics for the
U.S., machinery and equipment for France and the
automotive industry for Germany. See table 4 for
export exposure to China by country and sector.
Least likely scenario for us, Overshoot and
postpone (10% probability) would mean excessive
support à la 2009. GDP growth will be above +7%
this year and above +6.8% next year (+0.1pp for
world GDP in 2015). But this would be putting off
the evil hour: increase in corporate debt further and
maintained overcapacity would hinder rebalancing
through further increase in (low return) investments.
By Q2 2016, we will be back to where we are today,
with the same structural problems to solve.
Table 3: Five vulnerability indicators to China’s deceleration
Primary
Non-primary
commodity (net commodity (net
exports) % GDP exports) % GDP
Saudi Arabia
Kazakhstan
Australia
Chile
Peru
South Africa
Uruguay
Vietnam
Venezuela
Indonesia
Thailand
Brazil
Ukraine
Malaysia
Russia
New Zealand
Colombia
Philippines
Taiwan
Hong Kong
South Korea
Singapore
5.5%
4.8%
4.8%
2.9%
2.9%
2.9%
2.5%
2.5%
2.3%
1.9%
1.9%
1.7%
1.4%
1.4%
1.3%
1.3%
1.2%
0.8%
-0.2%
-0.9%
-0.1%
0.0%
-2.0%
-3.8%
-1.7%
-1.6%
-2.8%
-3.7%
-3.5%
-24.1%
-1.4%
-3.1%
-2.8%
-1.5%
-4.8%
1.8%
-2.4%
-0.2%
-2.5%
-2.0%
12.6%
-7.6%
6.4%
0.2%
General
government net
lending (% GDP,
2014)
-0.5
1.9
-3.6
-1.4
-0.1
-4.1
-3.4
-5.4
-14.8
-2.2
-1.8
-6.2
-4.5
-3.7
-1.2
-0.6
-1.4
0.5
-2.5
5.3
0.3
4.2
General
Currency
government debt depreciations
(% GDP, 2014)
(July 2015, y/y)
2%
15%
34%
14%
21%
46%
63%
59%
46%
25%
47%
65%
71%
57%
18%
34%
38%
37%
38%
7%
36%
99%
0%
-2%
-22%
-15%
-13%
-15%
-18%
-2%
-14%
-14%
-9%
-33%
-44%
-16%
-41%
-22%
-35%
-5%
-5%
0%
-12%
-9%
Legend
Orange cells mean that
The country has positive surplus w ith China
General govt, net lending General govt debt is
is below -3% GDP
above 60% GDP
Depreciation is higher
than 10 %
Sources: Chelem, Euler Hermes
Euler Hermes Economic Research
4
Table 4: Export exposure to China (share of the sector in a country’s total exports to China)
Australia
Canada
Saudi Arabia
United States
India
Russian Federation
South Africa
Turkey
Argentina
Brazil
Mexico
France
Germany
Italy
United Kingdom
Indonesia
Japan
South Korea
World
Energy
Food agric
Textiles
Chemicals
Iron steel
Non ferrous
Machinery
Vehicles
Electrical
Electronic
11%
10%
8%
37%
0%
1%
0%
10%
58%
9%
0%
0%
0%
0%
10%
10%
6%
1%
1%
82%
0%
0%
2%
18%
0%
0%
0%
0%
0%
2%
24%
0%
1%
14%
2%
6%
10%
8%
3%
13%
4%
22%
15%
18%
9%
14%
5%
1%
1%
2%
65%
11%
0%
7%
4%
7%
4%
0%
0%
0%
6%
3%
0%
3%
39%
32%
1%
1%
0%
0%
0%
3%
8%
35%
3%
36%
3%
0%
1%
1%
13%
80%
3%
3%
1%
0%
0%
0%
0%
0%
9%
44%
1%
2%
35%
3%
1%
0%
0%
0%
8%
2%
1%
6%
9%
21%
3%
17%
7%
24%
0%
12%
3%
15%
2%
2%
44%
4%
5%
7%
0%
2%
1%
11%
1%
2%
32%
26%
10%
10%
0%
3%
15%
14%
2%
2%
39%
7%
4%
5%
2%
3%
1%
14%
2%
6%
16%
39%
2%
7%
36%
15%
3%
10%
3%
21%
1%
0%
3%
3%
1%
0%
2%
19%
6%
3%
18%
9%
10%
25%
6%
1%
2%
20%
3%
2%
9%
4%
13%
40%
20%
9%
2%
13%
8%
7%
8%
5%
5%
18%
Betw een 10% and 20%
More than 20%
Less than 10%
Sources: Chelem, Euler Hermes
DISCLAIMER
These assessments are, as always, subject to the disclaimer provided below.
This material is published by Euler Hermes SA, a Company of Allianz, for information purposes only and should not be regarded as
providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be
taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution
in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently
verified by Euler Hermes and Euler Hermes makes no representation or warranty (express or implied) of any kind, as regards the
accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any
way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are
solely those of the Euler Hermes Economics Department, as of this date and are subject to change without notice. Euler Hermes SA
is authorised and regulated by the Financial Markets Authority of France.
© Copyright 2015 Euler Hermes. All rights reserved.
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Research online
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Contact Euler Hermes
Economic Research Team
Publication Director
Ludovic Subran, Chief Economist
[email protected]
[email protected]
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